Thursday, February 9, 2012

More on Freddie Mac

More on the Freddie Mac saga: http://www.npr.org/2012/02/09/146585726/potential-conflicts-at-freddie-mac-draw-scrutiny




NPR really isn't letting this go, and I guess they are not aware of, or refusing to acknowledge, challenges to their "betting against homeowners" accusation along the lines of the naked capitalism piece. Recently they interviewed the FHFA head DeMarco over this, and from what I could tell, the questioning was somewhat biased by NPR standards, and DeMarco's answers seemed to get cut off more often than usual (you could hear his words getting cut off fairly noticeably). When asked why Freddie invested in inverse floaters, DeMarco explained that he was trying to avoid losses to taxpayers. But he never even touched on hedging risk and portfolio diversification. I know some listeners may find that stuff boring, but NPR has tackled CDS's and other complex financial stories before. So either DeMarco totally whiffed on PR, or NPR suppressed his full explanation. A former Freddie risk management exec was interviewed in the NPR series as well, and he expressed shock and disapproval of Freddie's actions. But his job was risk mgmt! Couldn't he explain the situation, or was he worried to swim against the populist tide and be labeled a Freddie apologist crony?



So now there is sufficient buzz and anger over this that Congress is holding hearings. As you would expect, lawmakers from both sides are quite upset. But from all the hours of testimony, you would think someone would bring up the risk issue. Congress and the public are rightfully still unconvinced that the rule-making and investment arms of Freddie are sufficiently segregated, so why can't the Freddie execs explain their internal workings and safeguards to protect against COI (if they exist)? It's tough because the tighter refi and restructuring rules were rolled out before Freddie invested more heavily in inverse floaters. So one could argue that the investment side took notice of the tighter refi rules, and then made sound bets accordingly. That is technically legal and may not even be unethical. But if the investment guys were pressuring the rules guys a priori to make refi rules tougher, in anticipation of taking these inverse floater positions, then that's much worse.



I guess conservatives have ostensibly been against GSE's since even before the housing crisis (they never complained when the GSE's were making investors a ton of cash though), saying that gov't participation in markets usually ends up bad. And the progressives are outwardly hostile to anything that remotely resembles a bank, even if it is a GSE under the stewardship of a Democratic administration. So no one is on Freddie's side now, whether fully justified or not. I'm wondering if Fannie has also made investments of the same nature. Fannie is basically a twin entity, but we haven't heard anything from their end.



Interestingly, Freddie got in similar hot water in 1997 when it was discovered that they invested $340M in Phillip Morris corporate bonds just as the investigations against Big Tobacco's misdeeds were building up. When the story broke, they quickly dumped that position. Maybe this suggests that GSE's, or any gov't entity in general, shouldn't bet on the private sector. Like Solyndra and insider trading by Congress, there's just too much chance for COI, or the suspicion of COI, which these days is almost as bad. Freddie is so big, and with so much influence, that it could affect its own investments and the market as a whole if it wanted. Yes it's great when our gov't can make some capital gains to counter all the billions we lose from interest payments on our debt. But with so much COI risk, maybe the gov't should limit itself to investments only in Treasuries (basically internal lending) or CDs. Yes their return will be lower, but the chance for impropriety will be greatly reduced too. I know this is probably impractical, but I'm just saying.

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